Technical Field
This invention relates to data management systems and more particularly to an automated system for aggregating and transforming data from disparate primary market trading and portfolio management computers to model and produce a daily basket, while maintaining confidentiality of securities selected and held by a non-transparent exchange-traded fund.
Background Information
An OMS (order management system) is a specialized computer system developed to manage and execute securities orders in an efficient and cost-effective manner. These systems execute at volumes, speeds and with levels of security and redundancy that require specialized computer hardware and software. Many versions of OMSs have been developed by various entities for use by particular parties to perform their distinct roles in the securities order and trading process. For example, OMSs are used on both the buy-side (e.g., by a fund) and the sell-side (e.g., brokers and dealers), with differing functionality. Brokers and dealers use OMSs specifically customized for their sell-side use when filling orders for various types of securities and are able to track the progress of each order throughout the system. Primary markets (exchanges) use OMSs that have been specifically customized for their use to manage their operations. Typically only exchange members can connect directly to an exchange, which means that sell-side OMSs may have exchange connectivity, whereas buy-side OMSs are concerned with connecting to sell-side firms. OMSs allow firms to input orders to the system for routing to pre-established destinations. They also allow firms to change, cancel and update orders. When an order is executed on the sell-side, the sell-side OMS must then update its state and send an execution report to the order's originating firm. OMSs support portfolio management by translating intended asset allocation changes into marketable orders for the buy-side. These asset allocation changes typically involve rebalancing a fund's asset allocation to correct for market valuation changes and cashflows, to align an Index Fund with its target index, and to make discretionary or tactical changes initiated by fund managers.
Because these changes often affect hundreds to hundreds of thousands of accounts creating hundreds of thousands of small orders, and because there is a legitimate fear of front running (i.e., the unethical practice of a stockbroker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers), orders are typically grouped into aggregate market orders and crossing orders. However, this solution offered by conventional OMSs, fails to solve the front running problem for actively managed, i.e., ‘non-transparent’, Exchange-traded funds (ETFs).
ETFs are essentially a special type of mutual fund (or, less commonly, unit investment trust (UIT)) whose shares trade on a securities exchange. ETFs shares may be created or redeemed in unit basket amounts by broker-dealer firms serving as “authorized participants” in the ETF. For most ETFs, creation and redemption of units takes place primarily through the delivery of baskets of securities that closely replicate the current unit holdings of the ETF. ETFs that trade publicly in the U.S. are registered under the 1940 Act as mutual funds or UITs, and are subject to the same investment restrictions as non-ETF versions of those vehicles.
In light of these complexities, specialized exchange-traded product (ETP) OMSs have been developed to help manage ETFs. ETP OMSs handle the sophisticated operational flows associated with ETFs, including the way their shares are created and redeemed. As mentioned, rather than cash, institutional investors usually deposit a basket (“creation basket”) of stocks “in kind” with the fund in exchange for ETF shares. Typically mirroring the ETF's portfolio, the contents of this creation basket are made available publicly on a daily basis. Likewise, ETF shares can be exchanged for a basket (“redemption basket”) of securities and, sometimes, cash. ETFs must generate these baskets day after day, involving sophisticated risk analytics as well as specialized front-office systems. The accounting side of the operation must also be managed accurately. A net asset value (NAV) for the ETF must not only be calculated at the end of each day, but also a projected NAV for the following day. And as ETF share prices can fluctuate during the day, the ETP OMS must also generate its own intraday version of the NAV. This in turn will determine the contents and hypothetical value of the next day's basket. An example of an ETP OMS is the FlexOMS ETF platform commercially available from FlexTrade System, Inc. (Great Neck, N.Y.). ETP OMS solutions are also commercially available from Charles River Development (CRD), Burlington, Mass.
ETFs were first introduced in the U.S. market in 1993 and have enjoyed a high rate of growth in assets and trading volume almost since its introduction. The vast majority of ETFs are ‘passive’, i.e., those based on popular benchmark indexes. Because the indexes are public, the contents of the publically disseminated creation/redemption baskets may closely approximate the holdings of the fund without a substantial risk of disclosing confidential trading activity that may be used for front running.
Today, however, many fund companies wish to offer ETF versions of their actively managed (‘non-transparent’) mutual funds, i.e., of mutual funds that do not simply follow popular benchmark indexes, but instead, are based on a portfolio of securities selected by active fund managers. Conventional facilities, including OMSs available for the operational management of passive ETFs are in many respects inappropriate for these ‘active’ or non-transparent ETFs, because daily publication of baskets that closely track the fund's holdings would risk disclosing the fund manager's strategies and promoting front running, etc. Moreover, because of the close alignment of baskets to fund holdings, other aspects of passive ETF management may be managed with less precision than would be desirable for active ETFs.
Therefore, a need exists for a system and method capable of retrofitting and leveraging conventional OMSs and infrastructure to create and manage baskets for active ETFs.